| Abstract | Qualified Securities for Short-sale Refinancing (QSSR) is a unique trading mechanism that affects the supply of securities available for short sales in Chinese capital markets. Using difference-in-difference methodology, we investigate whether and to what extent exogenous changes in the QSSR list lead to increases in short sale activities which in turn affect return volatilities, stock overvaluation, and asymmetric characteristics of return distribution. We find that as securities are added to the QSSR list, the volatility of returns and the frequency of extreme negative returns increase. In addition, QSSR stocks experience significantly negative abnormal return (AR) and cumulative abnormal return (CAR) than non-QSSR stocks, and the differences in both AR and CAR are positively related to investor heterogeneity. Moreover, the market beta for QSSR stocks increases in bear market while it declines in bull market. Our results indicate that the effect of short sales on share prices is mixed. On one hand, short sales reduce asset bubbles and asymmetric risk characteristics of asset returns, thus improving price discovery and promoting market stability. On the other hand, short sales lead to higher return volatility and increase the risk of market crashes. Therefore, securities regulatory authority has to continue to improve short sale and other trading mechanisms, and strictly enforce the law, so as to build a solid foundation in capital markets for attaining the national strategy of “mass entrepreneurship and innovation”. |